UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





(Mark One)


x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended June 30, 2009





OR





 ̈
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the transition period from ________ to _________





Commission file number 000-49636





VIKING SYSTEMS, INC.


(Exact name of registrant as specified in its charter)





Delaware

86-0913802(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)





134 Flanders Road, Westborough, MA 01581


(Address of principal executive offices) (Zip Code)





(508) 366-3668


(Registrant’s telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.   YES xNO  ̈





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).   YES  ̈NO o





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.




Large accelerated filer    ̈
Accelerated filer    ̈Non-accelerated filer (Do not check if a smaller reporting company) ̈
Smaller reporting company   x





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES  ̈NO x





The registrant had 42,715,110 shares of common stock, $0.001 par value per share, outstanding as of July 31, 2009.











FORM 10-Q





FINANCIAL STATEMENTS AND SCHEDULES


VIKING SYSTEMS, INC.





For the Quarter ended June 30, 2009





PART I - FINANCIAL INFORMATION





Form 10-QItem 1.
Financial Statements (unaudited):Balance Sheets at  June 30, 2009 and December 31, 2008
2Statements of Operations for the Three and Six  Months Ended June 30, 2009 and 2008
3Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008
4-5Notes to Financial Statements
6-9Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
10-13Item 3
Quantitative and Qualitative Disclosure About Market Risk
14Item 4T.
Controls and Procedures
14





PART II - OTHER INFORMATION





Item 1.
Legal Proceedings
15Item 1A.
Risk Factors
15-19Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
19Item 3.
Defaults Upon Senior Securities
19Item 4.
Submission of Matters to a Vote of Security Holders
19Item 5.
Other Information
19Item 6.
Exhibits
20-21













PART I - FINANCIAL INFORMATION





ITEM 1.   FINANCIAL STATEMENTS


VIKING SYSTEMS, INC.


Balance Sheets - Unaudited





June 30,


December 31,Assets

2009


2008Current assets:Cash and cash equivalents

$
311,711


$
168,767Accounts receivable, net


628,420



837,229Inventories, net


1,828,746



2,104,764Prepaid expenses


60,985



151,048Total current assets


2,829,862



3,261,808Property and equipment, net


83,057



223,609Intangible assets, net


175,000



210,000Total assets

$
3,087,919


$
3,695,417Liabilities and Stockholders' EquityCurrent liabilities:Accounts payable

$
1,103,090


$
1,432,460Accrued liabilities


861,921



794,219Deferred revenue


174,240



51,254Capital lease obligations


10,032



31,821Total current liabilities


2,149,283



2,309,754Commitments and contingenciesPreferred Stock, 25,000,000 shares authorizedSeries B redeemable preferred stock, $0.001 par value;No shares outstanding at June 30, 2009 and December 31, 2008


-



-Stockholders’ Equity:Common stock, $0.001 par value, 400,000,000 shares authorized; and 42,715,110 issued and outstanding at June 30, 2009 and  December 31, 2008


42,715



42,715Additional paid-in capital


26,796,625



26,566,607Accumulated deficit


(25,900,704
)


(25,223,659
)Total stockholders' equity


938,636



1,385,663Total liabilities and stockholders' equity

$
3,087,919


$
3,695,417








The accompanying notes are an integral part of the interim financial statements.


2





VIKING SYSTEMS, INC.


Statements of Operations -Unaudited




Three Months Ended


Six Months EndedJune 30,


June 30,2009


2008


2009


2008Sales, net

$
1,632,662


$
1,464,785


$
3,153,890


$
2,861,702Cost of sales


1,184,716



1,303,001



2,331,648



2,538,561Gross profit


447,946



161,784



822,242



323,141Operating expenses:Selling and marketing


270,332



402,741



501,227



793,564Research and development


133,079



192,698



280,800



430,206General and administrative


430,988



618,680



834,015



2,002,572Total operating expenses


834,399



1,214,119



1,616,042



3,226,342Operating loss


(386,453
)


(1,052,335
)


(793,800
)


(2,903,201
)Other income (expense):Interest income


240



2,036



750



17,273Interest expense


(320
)


-



(1,055
)


-Loss on recapitalization transaction


-



-



-



(2,703,776
)License fee


-



-



115,000



-Other income (expense)


-



(355
)


2,060



270,518Gain on derivative liability


-



-



-



307,061Total other income (expense)


(80
)


1,681



116,755



(2,108,924
)Net loss

$
(386,533
)

$
(1,050,654
)

$
(677,045
)

$
(5,012,125
)Net loss per share - basic and diluted

$
(0.01
)

$
(0.02
)

$
(0.02
)

$
(0.12
)Weighted average shares - basic and diluted


42,715,110



42,556,610



42,715,110



41,878,182








The accompanying notes are an integral part of the interim financial statements.


3





VIKING SYSTEMS, INC.


Statements of Cash Flows-Unaudited




Six Months Ended
June 30,2009


2008Cash flows from operating activities:Net loss

$
(677,045
)

$
(5,012,125
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


172,293



265,202Stock based compensation expense


230,018



845,324Gain on derivative liability


-



(307,061
)Loss on recapitalization transaction


-



2,703,776Changes in operating assets and liabilities:Accounts receivable


208,809



599,910Inventories, net


282,043



(685,252
)Prepaid expenses


90,063



(147,037
)Other current assets


-



108,512Accounts payable


(329,370
)


(185,236
)Accrued expenses


67,702



(541,236
)Deferred revenue


122,986



(46,084
)Net cash provided by (used in) operating activities


167,499



(2,401,307
)Cash flows from investing activities:Purchase of property and equipment


(2,766
)


(22,583
)Net cash used in investing activities


(2,766
)


(22,583
)





Cash flows from financing activities:Net proceeds from issuance of common stock


-



2,589,905Repayment of capital lease obligations


(21,789
)


(20,676
)Net cash (used in) provided by financing activities


(21,789
)


2,569,229Net increase in cash and cash equivalents


142,944



145,339Cash and cash equivalents at beginning of period


168,767



317,098Cash and cash equivalents at end of period

$
311,711


$
462,437Supplemental disclosure of cash flow information:Cash paid during the period for:Interest

$
1,055


$
1,767Income taxes

$
-


$
-








The accompanying notes are an integral part of the interim financial statements.


4





VIKING SYSTEMS, INC.


Statements of Cash Flows-Unaudited  (continued)





Non-cash, investing and financing activities:





There were no non-cash investing and financing activities during the six months ended June 30, 2009.





During the six months ended June 30, 2008, the Company:





●
Issued 22,400,020 shares of common stock in exchange for all outstanding convertible debentures and related accrued interest and liquidated damages.





●
Issued 4,197,849 shares of common stock in exchange for all outstanding Preferred Stock and related accrued dividends, interest on unpaid dividends and liquidated damages.





●
Issued warrants to purchase 11,200,011 shares of the Company’s common stock to the former convertible debenture holders in exchange for their then outstanding warrants to purchase 443,141 shares of common stock.





●
Issued warrants to purchase 2,098,027 shares of the Company’s common stock to the former Preferred Stockholders in exchange for their then outstanding warrants to purchase 666,667 shares of common stock.





The accompanying notes are an integral part of the interim financial statements.




5





1.           INTERIM FINANCIAL STATEMENTS





The accompanying unaudited interim financial statements of Viking Systems, Inc. (“Viking” or the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 8 of Regulation S-X.
In the opinion of  management,  the interim financial statements reflect all adjustments necessary to make the financial statements presented not misleading. The balance sheet as of December 31, 2008 was derived from the Company's audited financial statements. The financial statements and notes thereto should be read in conjunction with the financial statements and notes for the year ended December 31, 2008, included in Viking's annual report on Form 10-K for the year ended
December 31, 2008,  which was filed on April 15, 2009 with the Securities and Exchange Commission. The results of operations and cash flows for the periods ended June 30, 2009 are not necessarily indicative of results to be expected for the fiscal year ending December 31, 2009.





2.           LIQUIDITY





The accompanying financial statements have been prepared on a going concern basis, which contemplates, among other things, the realization of assets and the satisfaction of liabilities in the ordinary course of business.  During the six months ended June 30, 2009, we incurred a net loss of $677,045.  For
the year ended December 31, 2008, the Company recorded a net loss of $5,752,057 and cash used in operating activities was $2,615,399.  As of June 30, 2009, the Company had $311,711 of cash and cash equivalents and a net working capital balance of $680,579.





Management believes that the Company’s existing cash resources, combined with projected cash flows from operations may not be sufficient to execute its business plan and continue operations for the next twelve months.  Management has taken steps to reduce the Company’s operating expenses, and
continues to implement changes in its strategic direction aimed at achieving profitability and positive cash flow.    In addition, management continues to explore various strategic alternatives, including business combinations, private placements of debt or equity securities and strategic licensing or other arrangements.   In November 2008, the Company engaged an investment banking firm to assist management in exploring business combinations and/or raising additional capital.  This
process is ongoing. However, the Company may not be successful in executing a business combination or in obtaining additional financing on acceptable terms, on a timely basis, or at all, in which case, the Company may be forced to make further cut backs, or cease operations.  The financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern





3.           LOSS PER SHARE





The computation of basic and diluted loss per common share is computed using the weighted average number of common shares outstanding during the year.





Due to the net losses for the three and six month periods ended June 30, 2009 and June 30, 2008, potentially dilutive securities have been excluded in the calculation of diluted loss per share because their inclusion would be anti-dilutive. Accordingly, basic and diluted loss per share are the same within each respective
period.





The following potentially dilutive common shares were excluded from the calculation of diluted net loss per common share because their effect was antidilutive for the periods presented:




Three Months Ended


Six Months EndedJune 30,
2009


June 30,
2008


June 30,
2009


June 30,
2008Warrants


27,913,631



28,047,519



27,913,631



28,047,519Stock Options


6,504,440



6,940,840



6,504,440



6,940,840Total


34,418,071



34,988,359



34,418,071



34,988,359




6





4.           INVENTORY





Details of our inventory account balances are as follows:





June 30,
2009


December 31,
2008Inventories:Parts and supplies

$
1,105,765


$
1,208,720Work-in-progress


383,723



426,779Finished goods


801,134



945,816Valuation reserve


(461,875
)


(476,551
)$
1,828,747


$
2,104,764





5.           ACCRUED LIABILITIES





Accrued liabilities consist of the following:





June 30,
2009


December 31,
2008Employee and director compensation

$
492,246


$
433,371Registration delay fees


161,574



161,574Professional and consulting fees


60,580



88,918Other accrued expenses


147,521



110,356$
861,921


$
794,219





6.           LICENSE AGREEMENT





In March 2009, the Company licensed one of its patents to a third party through September 2009.  The license is exclusive and is for use outside the medical products field.  The third party had previously licensed this patent through December 2006.  The license fee of $115,000 is included
in other income for the six months ended June 30, 2009.





7.           STOCK-BASED COMPENSATION





During the quarter ended March 31, 2008, shareholders approved  the Viking Systems, Inc. 2008 Equity Incentive Plan (the “2008 Equity Plan”), and the Viking Systems, Inc. 2008 Non-Employee Directors’ Stock Option Plan (the “Directors’ Plan,” ). The maximum number of shares
that may be issued pursuant to the 2008 Equity Plan is 6,720,000 shares plus such number of shares that are issuable pursuant to awards outstanding under the 2004 Plan as of the effective date and which would have otherwise reverted to the share reserve of the 2004 Plan. We have reserved a total of 1,500,000 shares of our common stock for issuance under the Directors’ Plan.  During the six months ended June 30, 2009 150,000 option were granted under the Directors’ Plan.  During
the six months ended June 30, 2008, 6,715,000 stock options were granted under the 2008 Equity Plan and 150,000 stock options were granted under the Directors’ Plan.





On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No.123 (Revised 2004), “Share Based Payment,” (“SFAS 123R”) using the modified prospective method. In accordance with SFAS 123R the Company measures the cost of employee services received
in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period. The Company determines the grant-date fair value of employee share options using the Black-Scholes option-pricing model.





During the three months ended June 30, 2009 and 2008, the Company recorded $112,257 and $120,533 respectively and during the six months ended June 30, 2009 and 2008, the Company recorded $230,018 and $845,324  respectively, in non-cash stock-based compensation expense pursuant to SFAS 123R. As of June
30, 2009, there was approximately $901,000 in total unrecognized compensation costs related to unvested options, which is expected to be recognized over a weighted average period of approximately 2.75 years.




7


During the six months ended June 30, 2009 150,000 stock options were granted with an exercise price equal to the quoted market price on the day of grant of $.04 per share. The valuation of such stock options was determined to be immaterial using the Black-Scholes valuation model. The fair value of stock options granted
during the six months ended June 30, 2008 was estimated using the Black-Scholes model with the following assumptions: volatility of 133%, life of 5-7 years, risk-free interest rate of 3.33%, and expected dividend yield of 0%. Volatility is based on the historical volatility of the Company's common stock. The life of employee stock options is based on the average of the vesting period and contractual life. The risk free interest rate is based on U.S. Treasury constant maturity rate for the expected life of
the stock option.




Using the assumption described above, the 6,865,000 stock options granted during the six months ended June 30, 2008 were valued at $1,779,528.





The following table summarizes the stock option transactions during the six months ended June 30, 2009:





Number of
Shares


Weighted - Average
Exercise
Price


Weighted -Average Remaining
Contractual
Life
(in years)Options outstanding December 31, 2008


6,354,440


$
0.58



9.11Granted


150,000


$
0.04



9.84Cancelled


-


$
-



-Options outstanding June 30, 2009


6,504,440


$
0.57



8.40Options exercisable at June 30, 2009


3,323,778


$
0.80



8.56





During the six months ended June 30, 2008, six employees surrendered 79,000 previously issued stock options. As a result, the total amount of shares issuable under 2008 Equity Plan increased by 79,000.   In connection with the surrender of stock options, during six months ended June 30, 2008 the Company
recognized the remaining non-cash stock option compensation of $410,258 related to these stock options.





8.           WARRANTS TO PURCHASE COMMON STOCK





The following table summarizes warrant activity during the six months ended June 30, 2009:




Shares


Range of
Exercise
Price


Weighted
Average
Exercise
Price


Weighted
Average
Remaining
Contractual
LifeWarrants outstanding December 31, 2008


27,985,020


$
0.18-0.35


$
0.18



4.0Expired


(71,389
)

$
0.35


$
0.35



-Exercised


-



-



-



-Outstanding June 30, 2009


27,913,631



0.18-0.35



0.18



3.50








8





9.           RECENT ACCOUNTING PRONOUNCEMENTS





The following accounting pronouncements were adopted effective January 1, 2009:





In June 2008, the Financial Accounting Standards Board (“FASB”) ratified Emerging Issues Task Force (“EITF”) Issue No. 07-5, “Determining whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock” (“EITF
07-5”). EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008, andinterim periods within those fiscal years. Early application was not permitted. Paragraph 11(a) of Statement of Financial Accounting Standards (“SFAS”) No. 133 - specifies that a contract thatwould otherwise meet the definition of a derivative but is both
(a) indexed to the Company's own stock and (b) classified in stockholders' equityin the statement of financial position would not be considered a derivative financial instrument. EITF 07-5 provides a new two-step model to beapplied in determining whether a financial instrument or an embedded feature is indexed to an issuer's own stock and thus able to qualify for theSFAS
No. 133 paragraph 11(a) scope exception. The  adoption of EITF 07-5 effective January 1, 2009 did not have a material impact on the Company’s financial statements





In February 2008, the FASB issued FASB Staff  Position (“FSP”) FSP 157-2, “ Effective Date of FASB Statement No. 157” (FSP 157-2). FSP 157-2 delayed the effective date of SFAS 157 for all non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. These include goodwill and other non-amortizable intangible assets.  The adoption of SFAS 157 with respect to non-financial assets and liabilities effective January 1, 2009 did not have a material impact on the Company’s financial statements.





In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under FAS 142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008.. The adoption of  FSP FAS 142-3  effective January 1, 2009 did not have a material impact on the Company’s financial statements.





The following accounting pronouncements were adopted during the quarter ended June 30, 2009:





In April 2009, the FASB issued FSP SFAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP SFAS No. 157-4”). FSP SFAS No. 157-4 provides additional
guidance for estimating fair value in accordance with FASB Statement No. 157 Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP SFAS No. 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective
of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. This statement is effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this pronouncement during the quarter ended June 30, 2009 did not have a material effect
on the Company’s financial statements.





In April 2009, the FASB issued FSP FAS No. 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS No. 107-1”). FSP FAS No. 107-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, to require disclosures
about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FSP FAS No. 107-1 also amends APB Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods. This statement became effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this pronouncement during the quarter ended June 30,
2009 did not have a material effect on the Company’s financial statements.




In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No. 165”). SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS
No. 165 was effective for fiscal years and interim periods ending after June 15, 2009. The adoption of this pronouncement during the quarter ended June 30, 2009 did not have a material effect on the Company’s financial statements.
  The Company has evaluated subsequent events that occurred after June 30, 2009, through August 7, 2009, the date the Company’s financial statements were issued.  During this period we did not have any material recognized or unrecognized subsequent events that required recognition or disclosure in our June 30,
2009 financial statements.
 
 Accounting pronouncements to be adopted during the quarter ended September 30, 2009:
  In June 2009, through the issuance of SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, the FASB confirmed that the FASB Accounting Standards Codification (the “Codification”) will become the single official source of authoritative
US generally accepted accounting principles (“US GAAP”)(other than guidance issued by the SEC), superseding existing FASB, American Institute of Certified Public Accountants, EITF, and related literature. After the effective date of the Codification, only one level of authoritative US GAAP will exist. All other literature will be considered non-authoritative. The Codification does not change US GAAP; instead, it introduces a new structure that is organized in an easily accessible, user-friendly
online research system. The Codification becomes effective for interim and annual periods ending on or after September 15, 2009. The Company will apply the Codification beginning in the quarter ending September 30, 2009. The adoption of the Codification will not have an effect on the Company’s financial statements, but will impact the Company’s future financial statement disclosures since all future references to authoritative accounting literature will be referenced in accordance with the Codification.




9


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS





This quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. You should not place undue reliance on these forward-looking statements.  Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including
the risks described in this report and other reports we file with the Securities and Exchange Commission. Although we believe the expectations reflected in the forward-looking statements are reasonable, they relate only to events as of the date on which the statements are made.  We do not intend to update any of the forward-looking statements after the date of this document to conform these statements to actual results or to changes in our expectations, except as required by
law.





The following discussion and analysis should be read in conjunction with the Financial Statements and Notes thereto, and other financial information included elsewhere in this quarterly report on Form 10-Q.





Overview





We are a worldwide developer, manufacturer and marketer of visualization solutions for complex minimally invasive surgery.  We partner with medical device companies and healthcare facilities to provide surgeons with proprietary visualization systems enabling minimally invasive surgical procedures, which
reduce patient trauma and recovery time.





We manufacture two dimensional, or 2D, digital cameras that are sold to third-party companies who sell to end users through their Original Design Manufacturer , or ODM, programs and Original Equipment Manufacturer, or OEM, programs.





We sell our proprietary visualization system, (3Di Vision System) under the Viking brand directly to hospitals and outpatient surgical centers in the United States and outside the United States through our distributor network.  We also sell our CardioCam/MiniCam product through these channels.





Liquidity and Capital Resources





On January 4, 2008, we completed execution of a Recapitalization Plan (the “Recapitalization Plan”).   In November 2007, we received approval, subject to finalization of certain terms and execution of final documentation, from 100% of the stockholders of our Series B Variable Dividend Convertible
Preferred Stock (the “Preferred Stock”) and our 8% Secured Convertible Debentures due February 23, 2009 (the “Debentures”), of the Recapitalization Plan.  The Recapitalization Plan called for an additional investment of $2.5 to $3.0 million (the “New Investment”) and a redistribution of our common stock among the current holders of our common stock, Preferred Stock, Debentures and the investors providing the New Investment.





In consummating the Recapitalization Plan, the redistribution of our capital was accomplished on January 4, 2008 through the following: (i) a 1 for 50 “reverse split” of our outstanding common stock, (ii) our entry into a Recapitalization Agreement with the applicable holders, pursuant to which the holders
of the Preferred Stock and Debentures exchanged their respective securities (including warrants that were issued in connection with the Preferred Stock and the Debentures) for shares of our common stock and warrants which may be exercised for common stock; and (iii) our entry into a Securities Purchase Agreement with those parties making the New Investment of $2.6 million pursuant to which they were issued shares of our common stock and warrants which may be exercised for shares of our common stock.  
As part of the recapitalization, we executed a Securities Purchase Agreement and completed a sale of 14,560,037 shares of our common stock for $0.178571 per share, or aggregate consideration of $2,600,000, of which we received net proceeds of $2,600,000.





In October 2007, our board of directors approved a revised strategic direction for our Company.  This strategy included focusing on our ODM/OEM business while significantly reducing expenses associated with our 3Di Vision Systems business.  We continued our 3Di Vision Systems business on
a reduced basis by utilizing our independent sales representatives and our existing distributor network.  The revised strategic direction of October 2007 enabled us to reduce expenses, primarily associated with the 3Di Vision Systems business, that are not expected to contribute to positive cash flow in the near term,  including the elimination of our U.S. direct sales force and a reduction in related clinical and marketing expenses.





In 2008, the board of directors re-evaluated this decision in light of our subsequent experience and considered various modifications to the business strategy.  The board determined to seek additional investment in our 3Di technology followed by investment in our U.S. distribution channels.  However,
we cannot implement these initiatives until we either enter into a business combination or raise substantial capital resources.   In November 2008 we engaged an investment banking firm to assist our management in exploring business combinations and/or raising additional capital.  This process continues.




10




Absent a business combination, we believe that we may need to raise additional capital to execute our business plan and continue our operations for the next twelve months. Such financing may not be available on acceptable terms, or at all. We do not have any arrangements with any bank, financial institutions or investors
to provide additional financing and there can be no assurance that any such arrangement, if required or otherwise sought, would be available on terms deemed to be commercially acceptable and in our best interests. If we fail to secure such financing and we are not generating positive cash flow, we will consider other options, including curtailing operations or seeking bankruptcy protection.





Since our inception, we financed our operations principally through private sales of equity securities and convertible debt. From January 1, 2004 through  June 30, 2009, we have raised net proceeds of $10,750,000 through the sale of common and preferred stock in private placements and approximately $13,600,000
through the issuance of convertible notes and debentures. As of June 30, 2009, we had cash of  $311,711.





Net cash provided by operating activities for six months ended June 30, 2009 was $167,499.  Net cash used in operating activities for the six months ended June 30, 2008 was $2,401,307. This improvement in cash flows from operating activities was attributable primarily to a smaller loss for the six
months ended June 30, 2009 combined with net cash generation during 2009 from the combined changes in inventory, accounts receivable, accounts payable and accrued expenses compared with net cash consumed in those combined changes during the same period in 2008.





Net cash used in financing activities was $21,789 during the six months ended June 30, 2009 compared with net cash provided by financing activities of $2,569,229  during the six months ended June 30, 2008. The net cash provided by financing activities in 2008 resulted from the sale of common stock
in connection with our Recapitalization Plan. We completed no such financing activities during the six months ended June 30, 2009.





RESULTS OF OPERATIONS





Three and Six Month Period Ended June 30, 2009 Compared with the Three and Six Month Period Ended June 30, 2008





Sales.  We had sales of $1,632,662 for the three months ended June 30, 2009 and of $1,464,785 for the three months ended June 30, 2008, representing an increase of 11%.   For the six months ended June 30 2009, sales
increased 10% to $3,153,890 as compared with the same period in the prior year.  The increase in sales during 2009 was due to increased sales in both 3Di and OEM products and service.  During the three and six months periods ended June 30, 2009, we experienced increased demand and sales of our high definition cameras as well as our proprietary visualization system designed for and distributed by Boston Scientific as compared with the same periods of 2008.  Partially offsetting these
increases was a decrease in revenue recognized associated with a third party development contract for 3D vision products.





Sales to individual customers exceeding 10% of revenues in the three and six months ended June 30, 2009 were to three customers who accounted for 34%, 31% and 14% and 29%, 26% and 14% of revenues, respectively.





Gross Profit. Gross profit was $447,946 or 27.4% of sales for the three months ended June 30, 2009 and $161,784 or 11.5% of sales for the three months ended June 30, 2008, representing an increase of $286,162.   For the
six months ended June 30, 2009 gross profit was $822,242 or 26.1% of sales compared with $323,141 or 11.3% of sales for the same period in 2008.  The increase in gross margin percentage for both periods in 2009 is due to a favorable sales mix of higher margin products as well as higher production volumes resulting in lower per unit manufacturing costs.





Operating Expenses.  We incurred operating expenses of $834,399 for the three months ended June 30, 2009 and $1,214,119 for the three months ended June 30, 2008.  For the three months ended June 30, 2009
and 2008, excluding non-cash stock based compensation expense, total operating expenses were $731,889 and $1,093,586, respectively.





We incurred operating expenses of $1,616,042 for the six months ended June 30, 2009 and  $3,226,342 for the six months ended June 30, 2008.  For the six months ended June 30, 2009 and 2008, excluding non-cash stock based compensation expense, total operating expenses were $1,386,024
and $2,381,018, respectively.





This decrease in total operating expenses for both periods is due largely to our continued cost reduction efforts.





Sales and Marketing Expense. Sales and marketing expenses were $270,332 for the three months ended June 30, 2009 and $402,741 for the three months ended June 30, 2008.  Sales and marketing expenses were $501,227 for the six months
ended June 30, 2009 and $793,564 for the six months ended June 30, 2008.  This decreases of 33% and 37%, respectively are due to reductions in our marketing efforts, reduction in sales related headcount, and lower depreciation expense related to demonstration equipment. Partially offsetting these reductions was bad debt expense of $57,845 in the quarter ended June 30, 2009.




11




Research and Development Expense.  We had research and development expenses of $133,079 for the three months ended June 30, 2009 and $192,698 for the three months ended June 30, 2008, representing a decrease of $59,619. For
the six months ended June 30, 2009 research and development expense was $280,800 compared with $430,206, a decrease of $149,406. The decrease for both periods occurred primarily due to the reduction of personnel focused on research and development activities.





General and Administrative Expense.  General and administrative expenses include costs for administrative personnel, legal and accounting expenses and various public company expenses. General and administrative expenses were $430,988
for the three months ended June 30, 2009 and $618,680 for the three months ended June 30, 2008.  During the three months ended June 30, 2009, we recorded $112,257 related to non-cash stock option compensation expense compared with $120,533 for the same period in 2008.  Excluding these charges, general and administrative expense decreased $179,416.  Legal expense decreased approximately $57,518 as compared with the prior year. We also incurred lower audit related expenses in
2009 compared with the same period in 2008.





General and administrative expenses were $834,015 for the six months ended June 30, 2009 and $2,002,572 for the six months ended June 30, 2008.  During the six months ended June 30, 2009, we recorded $230,018 related to non-cash stock option compensation expense compared with $845,324 for the same period
in 2008.  Excluding these charges, general and administrative expense decreased $553,251 or 48%. Legal expense decreased approximately $248,086 as compared with the prior year. We also incurred lower audit related expenses in 2009 compared with the same period in 2008. Additionally, we accrued an employee separation charge of approximately $90,000 during the quarter ended June 30, 2008 that was not repeated in 2009.





Other Income and Expenses.  During the six months ended June 30, 2009, other income and expense totaled to income of $116,755 compared with a net charge of $2,108,924 for the same period in 2008.  During the first quarter
of 2009 we recorded $115,000 of license fee income related to the granting of a license to use one of our patents in the nonmedical markets.  During the first quarter of 2008, we recorded a charge of $2,703,776 related to the recapitalization transaction.  This charge was offset by the reversal of approximately $271,000 related to accrued fees associated with our failure to file a registration statement for common stock and warrants issued during 2006.  Additionally, during
the first quarter of 2008, we recorded a non-cash gain on derivative liability of $307,061 related to the decrease in value of our derivative instruments.





Operating Loss Before Non-Cash Charges





A reconciliation of net loss in accordance with U.S. generally accepted accounting principles (GAAP) to the non-GAAP measure of operating loss before non-cash charges is as follows:




Three Months Ended
June 30,


Six Months Ended
June 30,2009


2008


2009


2008Net loss, as reported

$
(386,533
)

$
(1,050,654
)

$
(677,045
)

$
(5,012,125
)Adjustments:Total other (income)/expense


80



(1,681)



(116,755
)


2,018,924Non-cash stock option expense


112,257



120,533



230,018



845,324Depreciation and amortization


80,799



133,689



172,293



265,202Operating loss before non-cash charges

$
(193,397
)

$
(798,113
)

$
(391,489
)

$
(1,882,675
)





Off-Balance Sheet Arrangements





We do not currently have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes.





Use of Estimates and Critical Accounting Policies





This Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.





The preparation of our financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
period. On an ongoing basis, management evaluates its estimates and assumptions, including those related to inventory, income taxes, long lived asset valuation, revenue recognition, stock-based compensation and derivative liabilities. Management bases its estimates and judgments on historical experience of operations and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.




12




Management believes the following critical accounting policies, among others, will affect its more significant judgments and estimates used in the preparation of our Financial Statements.





Inventory.Parts and supplies inventories are stated at the lower of cost or market. Cost is determined using the standard cost method which approximates actual cost. Work-in-process and finished goods are stated at the lower of the accumulated
manufacturing costs or market.We reduce the stated value of our inventory for obsolescence or impairment in an amount equal to the difference between the cost of the inventory and the estimated market value, based upon assumptions about future demand and market conditions. If actual future demand or market conditions are less favorable than those projected by management, additional reductions in stated value may be required.





Income Taxes.In determining the carrying value of our net deferred tax assets, we must assess the likelihood of sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions, to realize the benefit of
these assets. If these estimates and assumptions change in the future, we may record a reduction in the valuation allowance, resulting in an income tax benefit in our Statements of Operations. Management evaluates the realizability of the deferred tax assets and assesses the valuation allowance quarterly.





Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109. The implementation of FIN 48 had no impact on our financial statements.





We are primarily subject to U.S. federal and state income tax. Tax years subsequent to December 31, 2003 remain open to examination by U.S. federal and state tax authorities. In addition, our policy is to recognize interest and penalties related to income tax matters in income tax expense. As of June 30, 2009,
we had no accruals for interest or penalties related to income tax matters.





Amortization and Impairment of Long Lived Assets.Long lived assets, such as property, equipment and intangible assets are recorded at historical cost. We amortize our intangible assets using the straight-line method over their estimated
useful lives, usually two to five years. We review intangible assets subject to amortization periodically to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life of the applicable asset. Conditions that would indicate impairment and trigger a more frequent impairment assessment include, but are not limited to a significant adverse change in the legal factors or business climate that could affect the value of
an asset, or an adverse action or assessment by a regulator. If the carrying amount of an asset exceeds its estimated fair value, an impairment charge is recognized for the amount by which the carrying amount exceeds the estimated fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less the estimated costs to sell. In addition, depreciation of the asset ceases. During the six months ended June 30, 2009 and 2008, no impairment of long-lived assets was
recorded.





Revenue Recognition. Our revenues are derived from the sale of surgical visualization technology products to end users, distributors and original equipment manufacturers. Revenue from the sale of products is recognized when evidence of an
arrangement exists, the product has been shipped, the selling price is fixed or determinable,  collection is reasonably assured and when both title and risk of loss transfer to the customer, provided that no significant obligations remain. If installation is included as part of the contract, revenue is not recognized until installation has occurred, or until any remaining installation obligation is deemed to be perfunctory. Shipping and handling costs are included in cost of sales.





For the sale of products and services as part of a multiple-element arrangement, we allocate revenue from multiple-element arrangements to the elements based on the relative fair value of each element. For sales of extended warranties with a separate contract price, Viking defers revenue equal to the separately stated
price. Revenue associated with undelivered elements is deferred and recorded when delivery occurs.





Stock-Based Compensation. On January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No.123 (Revised 2004), “Share Based Payment,” (“SFAS 123R”), using the modified prospective
method. SFAS 123R requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values. The Company uses the Black-Scholes option valuation model to estimate the fair value of its stock options at the date of grant. The Black-Scholes option valuation model requires the input of subjective assumptions to calculate the value of stock options. The Company uses historical data among other information to estimate the expected
price volatility, the expected annual dividend, the expected option life and the expected forfeiture rate.




13


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





As a Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in Item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item.





ITEM 4T. CONTROLS AND PROCEDURES





Limitations on the Effectiveness of Controls





We seek to improve and strengthen our control processes to ensure that all of our controls and procedures are adequate and effective. We believe that a control system, no matter how well designed and operated, can only provide reasonable, not absolute, assurance that the objectives of the controls system are met.
In reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, a control may become inadequate because of changes in conditions,
or the degree of compliance with policies or procedures may deteriorate. No evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company will be detected.  As set forth below, our Chief Executive Officer and our Executive Vice President and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were sufficiently effective to provide
reasonable assurance that the objectives of our disclosure control system were met.





Evaluation of Effectiveness of Disclosure Controls and Procedures





Our management evaluated, with the participation of our principal executive officer and our principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”))
as of the end of the period covered by this quarterly report on Form 10-Q. Based on that evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures as of June 30, 2009 are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) are accumulated and
communicated to our management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial
reporting. Management's assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance that the control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system's objectives will be met.





Changes in Internal Control over Financial Reporting





There were no changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the last quarter that have materially affected, or are reasonably likely to materially affect, our internal control
over financial reporting.







14





PART II - OTHER INFORMATION





ITEM 1. LEGAL PROCEEDINGS.





From time to time, we may become involved in various lawsuits and legal proceedings that arise in the ordinary course of business. We are currently not aware of, nor do we have any knowledge of, any such legal proceedings or claims against us or our officer and directors in their capacity as such that we believe
will have, individually or in the aggregate, a material adverse affect on our business, financial condition or operating results.





ITEM 1A. RISK FACTORS.





Forward Looking Statements





This interim report on Form 10-Q contains and incorporates by reference certain “forward-looking statements” with respect to results of our operations and businesses. All statements, other than statements of historical facts, included in this report on Form 10-Q, including those regarding market trends,
our financial position, business strategy, projected costs, and plans and objectives of management for future operations, are forward-looking statements. In general, such statements are identified by the use of forward- looking words or phrases including, but not limited to, “intended,” “will,” “should,” “may,” “expects,” “expected,” “anticipates,” and “anticipated” or the negative thereof or variations thereon or
similar terminology. These forward-looking statements are based on our current expectations. Although we believe that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct and our actual results could differ materially. These forward-looking statements represent our judgment as of the date of this Form 10-Q. We disclaim, however, any intent or obligation to update our forward-looking statements, except as required
by law.





Risks Related to our Business





Our Independent Auditors have expressed substantial doubt about our ability to continue as a going concern.





The report dated April 15, 2009 from our independent registered public accounting firm, Squar, Milner, Peterson, Miranda & Williamson, LLP, on our financial statements for the year ended December 31, 2008 included a going concern explanatory paragraph in which they stated that the financial statements were
prepared assuming that we would continue as a going concern and that there was substantial doubt regarding the Company’s ability to continue as a going concern.  Our ability to continue as a going concern is an issue raised as a result of our significant operating losses and negative operating cash flows.  During the six months ended June 30, 2009, we incurred a net loss of $677,045.  During the years ended December 31, 2008 and 2007, we incurred net losses of $5,752,057
and $923,290, respectively, and we incurred negative cash flows from operating activities of $2,615,399 and $6,792,845, respectively.  We will need to generate significant revenue in order to achieve profitability and we may never become profitable.  The going concern explanatory paragraph in the independent auditor's report emphasizes the uncertainty related to our business as well as the level of risk associated with an investment in our common stock.





We require additional financing and our inability to raise additional capital on acceptable terms in the future may have a material adverse effect on our business and financial condition.





We believe that we may need to seek a business combination or additional financing in order to fund our operations and carry out our business plan for the next twelve months. The overall weakening of the economy and increased financial instability of many borrowers has resulted in a general tightening of capital
availability.  Many lending and investing institutions that have traditionally been sources of capital have experienced significant losses and a lack of liquidity. These conditions may adversely impact our ability to raise capital. There can be no assurance that a business combination or such financing will be available on acceptable terms, or at all. We do not have any arrangements with any bank or financial institution to provide additional financing and there can be no assurance that any such arrangement,
if required or otherwise sought, would be available on terms deemed to be commercially acceptable and in our best interests. Also, if we raise additional funds by selling equity or equity-based securities, the percentage ownership of our existing stockholders will be reduced and such equity securities may have rights, preferences or privileges senior to those of the holders of our common stock. Any inability to obtain additional cash as needed could have a material adverse effect on our financial position, results
of operations and ability to continue operations.





As part of managing our business, we frequently forecast our future cash flow and cash position.  Such projections include assumptions regarding fulfillment of existing orders, receipt and fulfillment of future orders and ultimately the receipt of cash.  These forecasts also include assumptions
regarding the timing of payments related to existing and future liabilities and inventory procurement.   If forecasted orders do not materialize or existing orders were cancelled or reduced, this could have a material adverse impact on our projected cash position and our ability to continue our operations.




15


The recent deterioration of the economy and credit markets may adversely affect our future results of operations.





Our operations and performance depend to some degree on general economic conditions and their impact on our customers’ finances and purchase decisions.  As a result of recent economic events, potential customers may elect to defer purchases of capital equipment items, such as the products we manufacture
and supply.  Additionally, the credit markets and the financial services industry have been experiencing a period of upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the United States government. While the ultimate outcome of these events cannot be predicted, it may have a material adverse effect on our customers’ ability to fund their operations thus adversely impacting their ability to purchase
our products or to pay for our products on a timely basis, if at all.  These and other economic factors could have a material adverse effect on demand for our products, the collection of payments for our products and on our financial condition and operating results.





We will likely face significant competition which could adversely affect our revenues, results of operations and financial condition.





The market for medical products and services is highly competitive and new offerings and technologies are becoming available regularly.  Many of our competitors are substantially larger and more experienced than we are.  In addition, they have longer operating histories and have materially greater
financial and other resources than we do.  If we cannot compete in the marketplace, we may have difficulty selling our products and generating revenues.  Additionally, competition may drive down the prices of our products, which could adversely affect our cost of goods sold and our profitability, if any.  We cannot guarantee that we will compete successfully against our potential competitors.





We depend upon our executive officers and key personnel.





Our performance depends substantially on the performance of our executive officers and other key personnel. Our future success will depend to a large extent on retaining our employees and our ability to attract, train, retain and motivate sufficient qualified employees to fill vacancies created by attrition
or expansion of our operations.  The loss of the services of any of our executive officers or key personnel could have a material adverse effect on our business, revenues, and results of operations or financial condition.





Competition for talented personnel is intense, and we may not be able to continue to attract, train, retain or motivate other highly qualified technical and managerial personnel in the future.  In addition, market conditions may require us to pay higher compensation to qualified management and technical
personnel than we currently anticipate. Any inability to attract and retain qualified management and technical personnel in the future could have a material adverse effect on our business, prospects, financial condition, and/or results of operations.





We rely on a small number of customers and cannot be certain they will consistently purchase our products in the future.





Sales to individual customers exceeding 10% of revenues in the six months ended June 30, 2009 were to three customers who accounted for 29%, 26% and 14% of revenues, respectively. Sales to individual customers exceeding 10% of revenues in the year ended December 31, 2008 were to three customers who accounted for
30%, 19% and 11% of revenues, respectively.  No other customer accounted for more than 10% of our revenues during those periods.  In the future, a small number of customers may continue to represent a significant portion of our total revenues in any given period. We cannot be certain that such customers will consistently purchase our products at any particular rate over any subsequent period.  A loss of any of these customers could adversely affect our financial performance.




16


We are subject to significant domestic and international regulations and may not be able to obtain necessary regulatory clearances to sell our products.





The manufacture and sale of medical devices intended for commercial distribution are subject to extensive governmental regulation.  Our failure to comply with regulatory requirements would jeopardize our ability to market our products.  Noncompliance with applicable requirements can result in failure of
the regulatory agency to grant pre-market clearance or approval for devices, withdrawal or suspension of approval, total or partial suspension of production, fines, injunctions, civil penalties, refunds, recall or seizure of products and criminal prosecution. Medical devices are regulated in the United States primarily by the FDA and, to a lesser extent, by state agencies.  Sales of medical device products outside the United States are subject to foreign regulatory requirements that vary from country to
country.  Generally, medical devices require pre-market clearance or pre-market approval prior to commercial distribution.  A determination that information available on the medical device is not sufficient to grant the needed clearance or approval will delay market introduction of the product.  In addition, material changes or modifications to, and changes in intended use of, medical devices also are subject to FDA review and clearance or approval.  The FDA regulates the research, testing,
manufacture, safety, effectiveness, labeling, storage, record keeping, promotion and distribution of medical devices in the United States and the export of unapproved medical devices from the United States to other countries.  The time required to obtain approvals required by foreign countries may be longer or shorter than that required for FDA clearance, and requirements for licensing may differ from FDA requirements.  The current regulatory environment in Europe for medical devices differs significantly
from that in the United States.





We must be able to adapt to rapidly changing technology trends and evolving industry standards or we risk our products becoming obsolete.





The medical device market in which we compete is characterized by intensive development efforts and rapidly advancing technology.  Our future success will depend, in large part, upon our ability to anticipate and keep pace with advancing technology and competing innovations.  We may not be successful in
identifying, developing and marketing new products or enhancing our existing products. We believe that a number of large companies, with significantly greater financial, manufacturing, marketing, distribution and technical resources and experience than ours, are focusing on the development of visualization products for minimally invasive surgery.





Our operating results may be adversely affected by the level of reimbursements for surgical procedures using our products.





The level of payments for the surgical procedures, in which our products are involved, either by Medicare or private insurance companies may have a significant impact on future operating results.  We could be adversely affected by changes in payment policies of government or private health care payers, particularly
to the extent any such changes affect payment for the procedure in which our products are intended to be used.  It is a continuing trend in United States health care for such payments to be under continual scrutiny and downward pressure.  We believe that reimbursement in the future will be subject to increased restrictions, both in the United States and in foreign markets and that the overall escalating cost of medical products and services has led to and will continue to lead to increased pressures
on the health care industry, both foreign and domestic, to reduce the cost of products and services, including products which we offer.





We expect that our products typically will be used by hospitals and surgical centers, which bill various third-party payers, such as governmental programs and private insurance plans, for the health care services provided to their patients.  Third-party payers carefully review and increasingly challenge the
prices charged for medical products and services or negotiate a flat rate fee in advance.  Payment rates from private companies also vary depending on the procedure performed, the third-party payer, the insurance plan and other factors.  Medicare compensates hospitals at a predetermined fixed amount for the costs associated with an in-patient hospitalization based on the patient’s discharge diagnosis and compensates physicians at a pre-determined fixed amount based on the procedure performed,
regardless of the actual costs incurred by the hospital or physician in furnishing the care and unrelated to the specific devices or systems used in that procedure.  Medicare and other third-party payers are increasingly scrutinizing whether to cover new products and the level of payment for new procedures.  The flat fee reimbursement trend is causing hospitals to control costs strictly in the context of a managed care system in which health care providers contract to provide comprehensive health care
for a fixed cost per person.  We are unable to predict what changes will be made in the reimbursement methods utilized by such third-party payers.




17




If we obtain the necessary foreign regulatory registrations or approvals, market acceptance of our products in international markets would be dependent, in part, upon the acceptance by the prevailing health care financing system in each country.  Health care financing systems in international markets vary significantly
by country and include both government sponsored health care programs and private insurance.  We cannot assure you that these financing systems will endorse the use of our products.





We may be subject to product liability claims and have limited insurance coverage.





By engaging in the medical devices business, we will face an inherent business risk of exposure to product liability claims in the event that the use of our products results in personal injury or death.  Also, in the event that any of our products proves to be defective, we may be required to recall or
redesign such products. We will need to maintain adequate product liability insurance coverage.  If we are able to maintain insurance, of which there can be no assurance, our coverage limits may not be adequate to protect us from any liabilities we might incur in connection with the development, manufacture and sale of our products.  Product liability insurance is expensive and in the future may not be available to us on acceptable terms, if at all.  A successful product liability claim or
series of claims brought against us in excess of our insurance coverage or a product recall would negatively impact our business.





Risks Related to our Stock





Investors who purchase shares of our common stock should be aware of the possibility of a total loss of their investment.





An investment in our common stock involves a substantial degree of risk.  Before making an investment decision, you should give careful consideration to the risk factors described in this section in addition to the other information contained in this annual report.  The risk factors described herein, however,
may not reflect all of the risks associated with our business or an investment in our common stock.  You should invest in our Company only if you can afford to lose your entire investment.





Our current management, along with a select few investors, possess a majority of our common stock and they may be able to control our Company indefinitely.





A few of our stockholders have significant control over our voting stock which may make it difficult to complete some corporate transactions without their support and may prevent a change in control.  As of June 30, 2009, our directors and executive officers as a whole, may beneficially own approximately
18,612,916 shares or  43.6% of our outstanding common stock, and assuming that the warrants and options (exercisable as of 60 days from June 30, 2009) were exercised, may beneficially own approximately 35,132,832 shares or  59.3% of our outstanding common stock.  Certain of our officers and directors disclaim beneficial ownership of certain shares included in the description above. As of June 30, 2009, all of the warrants and options included in the above calculation were at exercise
prices above the quoted market price of our common stock.





The above-described significant stockholders may have considerable influence over the outcome of all matters submitted to our stockholders for approval, including the election of directors. In addition, this ownership could discourage the acquisition of our common stock by potential investors and could have an anti-takeover
effect, possibly depressing the trading price of our common stock.





“Penny stock” rules may make buying or selling our securities difficult, which may make our stock less liquid and make it harder for investors to buy and sell our securities.





Our common stock currently trades on the Over-the-Counter Bulletin Board.  If the market price per share of our common stock is less than $5.00, the shares may be “penny stocks” as defined in the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act.  As a result,
an investor may find it more difficult to dispose of or obtain accurate quotations as to the price of these securities.  In addition, “penny stock” rules adopted by the SEC under the Exchange Act subject the sale of these securities to regulations which impose sales practice requirements on broker-dealers.  For example, broker-dealers selling penny stocks must, prior to effecting the transaction, provide their customers with a document that discloses the risks of investing in penny
stocks.





Furthermore, if the person purchasing the securities is someone other than an accredited investor or an established customer of the broker-dealer, the broker-dealer must also approve the potential customer’s account by obtaining information concerning the customer’s financial situation, investment experience
and investment objectives.  The broker-dealer must also make a determination whether the customer has sufficient knowledge and experience in financial matters to be reasonably expected to be capable of evaluating the risk of transactions in penny stocks. Accordingly, the SEC’s rules may limit the number of potential purchasers of shares of our common stock.  Moreover, various state securities laws impose restrictions on transferring “penny stocks,” and, as a result, investors
in our securities may have their ability to sell their securities impaired.




18


If an active, liquid trading market for our common stock does not develop, you may not be able to sell your shares quickly or at or above the price you paid for it.





Although our common stock currently trades on the Over-the-Counter Bulletin Board, an active and liquid trading market for our common stock has not yet and may not ever develop or be sustained.  You may not be able to sell your shares quickly or at or above the price you paid for our stock if trading in
our stock is not active.





We do not expect to pay dividends in the foreseeable future.





We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will depend on our financial condition, results of operations, capital requirements and other factors and will be at the discretion of our board of directors.





ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.





We did not sell any unregistered securities during the quarter ended June 30, 2009.





ITEM 3. DEFAULTS UPON SENIOR SECURITIES.





As of  June 30, 2009, we are not in default with respect to any indebtedness.





ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.





We did not submit any matters to a vote of security holders during the quarter ended June 30, 2009.





ITEM 5. OTHER INFORMATION.





None.




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ITEM 6. EXHIBITS





ExhibitNumber
Exhibit3.1
Certificate of Incorporation dated June 8, 2006 (included as Exhibit 3.1 to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007, and incorporated herein by reference).3.2
Bylaws (included as Exhibit 3.3 to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007, and incorporated herein by reference).4.1
Certificate of Preferences, Rights and Limitations of Series B Variable Dividend Convertible Preferred Stock (included as Exhibit 4.01 to the Form 8-K filed May 25, 2006, and incorporated herein by reference).10.1
Stock Incentive Plan, dated March 31, 2004 (included as Exhibit 10.1 to the Form 8-K filed April 1, 2004, and incorporated herein by reference).10.2
2004 Non-Employee Director Stock Ownership Plan dated December 29, 2005 (included as Exhibit 10.2 to the Form 8-K filed April 1, 2004, and incorporated herein by reference).10.3
Employment Agreement between the Company and John Kennedy, dated October 10, 2005 (included as Exhibit 10.3 to the Form 8-K filed October 27, 2005, and incorporated herein by reference).10.4
Independent Sales Agent Agreement between the Company and Platinum Medical Inc., dated November 21, 2006 (included as Exhibit 10.17 to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2006, and incorporated herein by reference).10.5
Lease between the Company and Robert F. Tambone as Trustee of MAT Realty Trust, dated September 23, 2004 (included as Exhibit 10.1 to the Form 8-K filed October 1, 2004, and incorporated herein by reference).10.6
First Amendment to Lease between the Company and Robert F. Tambone as Trustee of MAT Realty Trust, dated February 5, 2007 (included as exhibit 10.18 to the Registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2006, and incorporated herein by reference).10.7
Securities Purchase Agreement between the Company and various investors, dated February 23, 2007 (included as Exhibit 10.1 to the Form 8-K filed February 27, 2007, and incorporated herein by reference).10.8
Amendment to Securities Purchase Agreement between the Company and various investors, dated July 19, 2007 (included as Exhibit 10.11 to the Form 8-K filed August 2, 2007, and incorporated herein by reference).10.9
Securities Purchase Agreement between the Company and various investors, dated July 31, 2007 (included as Exhibit 10.1 to the Form 8-K filed August 2, 2007, and incorporated herein by reference).10.10
Registration Rights Agreement between the Company and various investors, dated February 23, 2007 (included as Exhibit 10.1 to the Form 8-K filed February 27, 2007, and incorporated herein by reference).10.11
Amendment No. 1 to Registration Rights Agreement between the Company and various investors, dated July 19, 2007 (included as Exhibit 10.7 to the Form 8-K filed August 2, 2007, and incorporated herein by reference).10.12
Common Stock Purchase Warrant, dated February 23, 2007 (included as Exhibit 10.4 to the Form 8-K filed February 27, 2007, and incorporated herein by reference).10.13
8% Secured Convertible Debenture, dated July 31, 2007 (included as Exhibit 10.2 to the Form 8-K filed August 2, 2007, and incorporated herein by reference).




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10.14
Consent, Waiver and Amendment Agreement, dated February 23, 2007 (included as Exhibit 10.6 to the Form 8-K filed February 27, 2007, and incorporated herein by reference).10.15
Revised Consent, Waiver and Amendment Agreement, dated July 22, 2007 (included as Exhibit 10.10 to the Form 8-K filed August 2, 2007, and incorporate herein by reference).10.16
Consent, Waiver and Amendment Agreement, dated July 19, 2007 (included as Exhibit 10.6 to the Form 8-K filed August 2, 2007, and incorporated herein by reference).10.17
Security Agreement between the Company and various investors, dated February 23, 2007 (included as Exhibit 10.5 to the Form 8-K filed February 27, 2007, and incorporated herein by reference).10.18
Amendment No. 1 to Security Agreement between the Company and various investors, dated July 19, 2007 (included as Exhibit 10.2 to the Form 8-K filed August 2, 2007, and incorporated herein by reference).10.19
Recapitalization Agreement between the Company and Securityholders, dated December 31, 2007 (included as exhibit 99.1 to the Form 8-K filed January 7, 2008, and incorporated herein by reference).10.20
Securities Purchase Agreement between the Company and various investors, dated January 4, 2008 (included as Exhibit 99.2 to the Form 8-K filed January 7, 2008, and incorporated herein by reference).10.21
Executive Employment Agreement between the Company and William C. Bopp, dated January 4, 2008 (included as Exhibit 99.3 to the Form 8-K filed January 7, 2008, and incorporated herein by reference).10.22
Amendment to Executive Employment Agreement between the Company and William C. Bopp, dated February 27, 2008 (included as Exhibit 99.2 to the Form 8-K filed February 29, 2008, and incorporated herein by reference).31.1
Certification of Principal Executive Officer in accordance with 18 U.S.C. Section 1350, as adopted by Section 302 of the Sarbanes- Oxley Act of 200231.2
Certification of Principal Financial Officer in accordance with 18 U.S.C. Section 1350, as adopted by Section 302 of the Sarbanes-Oxley Act of 200232.1
Certification of Principal Executive Officer in accordance with 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 200232.2
Certification of Principal Financial Officer in accordance with 18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002





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SIGNATURE





Pursuant to the requirements of the Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





Dated: August 7, 2009
VIKING SYSTEMS, INC.By:
/s/ William C. BoppChief Executive Officer
(Principal Executive Officer)By:
/s/ Robert MathewsExecutive Vice President andChief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)












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